In an effort to tackle Britain’s rapidly rising prices, the Bank of England raised interest rates on Thursday, its first consecutive increases in more than 17 years, and said it would start cutting its huge holdings of government and corporate bonds. .
Inflation is already at its fastest pace in three decades: the annual rate reached 5.4% in December. But by April, the central bank expects it to climb to around 7.25%, the highest projection the bank has ever made. In response, policymakers voted to raise interest rates by 25 basis points to 0.5%.
But four of the nine policymakers wanted to do something bolder: a 50 basis point increase, a move twice as big. The bank has never approved such a large rate increase before.
The Bank of England raised interest rates in December for the first time in three and a half years, shrugging off the economic uncertainty created by Omicron and focusing on tackling inflation.
All in all, the bank expects Omicron to have weighed on the UK economy only in December and January, when inflation proves to be a much more persistent problem. Inflation is well above the central bank’s 2% target and even after it is expected to peak in April, it will remain above 5% for the rest of the year.
“We didn’t raise interest rates today because the economy is booming,” central bank governor Andrew Bailey told reporters on Thursday. The hike was “necessary because inflation is unlikely to return to target without it,” he said.
Mr Bailey noted that Britain is heavily affected by so-called imported inflation, generated by global factors, such as energy shortages and supply chain issues.
“We run the risk that some of the higher imported inflation could take root in the domestic economy, leading to a longer period of high inflation,” he added.
Half of the increase in inflation by April will be due to higher energy prices, the Bank of England said. Earlier on Thursday, Ofgem, Britain’s energy regulator, announced that the price cap on energy bills would rise by 54% in April for 22 million homes. The government has said it will try to ease the pain by giving millions of households £350, or $476, off bills this year in grants and loans.
The remainder of the projected rise in inflation over the next three months is expected to be split between higher prices for goods and services.
One of the main concerns of policy makers is that businesses and consumers will begin to assume that rapid cost increases will continue, which will force workers to demand higher wages in response and businesses to continue to raise their prices, fueling a cycle that keeps inflation rates higher for longer. .
In January, Catherine Mann, a member of the bank’s rate-setting committee, said it was the job of monetary policy to “lean” on expectations that could lead to this scenario.
But there are already signs that it is happening. Central bank economists expect pay deals to rise by almost 5% over the next year, based on surveys of companies it consults.
Yet prices are rising faster than wages. For months, higher inflation rates have raised concerns of a cost of living crisis in Britain, as household budgets, especially those on lower incomes, are squeezed by inflation of fastest food prices in a decade, higher energy bills and other rising costs.
The pressure is expected to be even worse than the central bank predicted just three months ago. For 2022, the bank’s after-tax and inflation net income measure is expected to fall 2% from a year ago, and fall again in 2023. In November, the central bank had forecast a 1.25% decline. in 2022.
Since 1990, this measure of income has declined only twice on an annual basis, in 2008 and 2011.
But ultimately, the pressure is meant to hamper the overall economy. Gross domestic product growth is expected to “slow to moderate rates,” according to the minutes of the rate-setting meeting that ended Wednesday. “The main reason for this is the negative impact of rising global energy and tradable goods prices” on income and expenditure. The central bank also expects it to bring the unemployment rate down to 5%, after falling to 3.8% in the first quarter.
This economic slowdown is expected to bring inflation back below the central bank’s target by 2024.
On Thursday, policymakers also voted to start cutting the bank’s bond holdings. The bank will stop reinvesting proceeds from maturing bonds into its holdings, which consist of £875bn of government bonds and £20bn of corporate bonds. Over this year and next, £70bn of government bonds will mature and reduce the size of the bank’s balance sheet. The bank will also sell its corporate bond holdings over the next two years.